With the current generation of video game consoles starting to age, game developers were expected to have an unimpressive harvest in 2004. Instead, game-software sales were up about 9% through November, according to industry estimates. And in response to the better-than-expected results, stocks in the sector thrived.
But with the next generation of consoles expected to debut in the coming year, developers might not be so fortunate. Software sales often have withered during past console transitions while development costs have mushroomed. Although industry executives have promised to do a better job of tending their businesses this time around, analysts disagree about how 2005 will turn out.
"It's a tougher call than it normally is," said Steve Monticelli, president of Mosaic Investments. (Monticelli doesn't have a stake in any of the video-game-software stocks.)
On one side, many analysts believe sales will be flat at best next year. The average price of games likely will fall as consumers anticipate the debut of the new consoles, they say. And the appearance of new hardware -- particularly two new handheld game machines -- could cut into software sales, they say.
"The consumer doesn't have unlimited funds," said Joe Spiegel, a fund manager with Dalek Capital. "The handheld market is likely to grow, but that money has to come out of somewhere." (Spiegel doesn't have a position in any of the video game-software stocks.)
But some analysts think 2005 could see plentiful sales. The new handheld platforms likely will boost software sales this year as consumers buy games to go with their new devices, said Wedbush Morgan analyst Michael Pacther, predicting that the overall game-software market will grow 10% next year. (Wedbush Morgan has not done any recent investment banking business for the major public gaming companies.)
Through November, U.S. consumers have spent about $5.3 billion on console, PC and handheld video games this year, up from about $4.9 billion, or 9%, in the same period last year, according to NPD. In contrast, game-software sales in the U.S. grew by just 1% in all of 2003.
Take-Two Interactive's (TTWO) - Get ReportGrand Theft Auto: San Andreas, and Microsoft's (MSFT) - Get ReportHalo 2, this year's top sellers, have boosted growth this year, said David Riley, a senior manager at NPD. But sales also have grown because this year's crop of games was a lot stronger than last year's, he said.
"It's like shooting fish in a barrel," Riley said. "There are so many great games on retailers' shelves."
Many analysts expect game sales to remain healthy through the first quarter. Because companies expected
overshadow fourth-quarter sales, a number of them moved key titles into the first quarter of next year.
, for instance, pushed back the release of the Xbox version of
to early next year. Likewise,
title back to March 2005.
Additionally, industry giant
, which likely will post strong sales in the first quarter.
"You have a ton of games coming out between now and March," noted Pachter.
On top of that, the new handhelds could help software sales.
released its new DS player last month and is expected to up its shipments in 2005. Rival
debuted its PSP unit in Japan this month and expects to launch it in the U.S. in the spring.
Hardware sales typically lead to greater software sales. Pachter projects that Nintendo will sell some 5 million DS units by the end of the year, which could lead to $300 million to $400 million in software sales in 2005. Sony should post similar hardware and software sales with its PSP, he said.
Right now, sales of DS hardware don't appear to be eating into sales of Nintendo's older Game Boy Advance handheld. And Pachter predicts that sales of DS games will be largely incremental to Game Boy software.
But not everyone is convinced that the new handhelds will save the software industry next year. The DS seems to be doing well so far, but whether it will appeal to older gamers than the Game Boy Advance remains to be seen, said one industry executive. Meanwhile, pricing issues may hamper PSP sales, the executive said.
While Sony is offering the PSP for less than $200 in Japan, many consumers are finding they need an extra battery pack and other accessories to make it useful, said the executive. That pushes the price up to well over $250.
"I think people are going to get a little sticker shock when they see what the PSP's real price is," said Spiegel.
And if portable sales don't materialize -- or if they eat significantly into gamers' budgets -- the software companies could suffer.
"A lot of (analysts) are saying there's going to be a smooth transition, but when you look at the DS and the PSP -- if they don't materialize, believe you me we are going have a repeat of the typical console transition," the executive said.
Regardless of the handheld market, the console market could well sink the entire software sector. Much depends on when Microsoft and Sony decide to release their new consoles and the games and features available on them, analysts say.
If Microsoft announces early in 2005 that the new Xbox won't be available until the fourth quarter and also can't play games made for the current Xbox, sales of current generation Xbox games will likely dry up, said Pachter.
"That's the biggest wild card," he said.
But some analysts see other potential threats. Many believe the average selling prices of game software will decline next year as consumers start to focus on next-generation consoles and games.
Console manufacturers' prices already have discounted their machines, which has helped push them into the mass market. But unlike avid gamers, mainstream customers aren't as willing to spend top dollar for new titles, analysts say.
"A lot of the mass market aren't that passionate about buying games," said the executive. "There's a lot of waiting around until the next thing comes along."